Will Korea be the next Japan?

by
Ronald Man

Economist, HSBC

There are parallels between the economies of South Korea and Japan

South Korea’s economy has grown 1,800 per cent since 1980 – more than three times the global growth rate. It has become the world’s 15th largest economy. Yet is its growth model too similar to that of Japan, which has experienced two decades of deflation and weak growth?

Korea needs to return the economy’s potential growth from 3.4 per cent to around 4 per cent

Korea has come a long way since the early 1960s, when its GDP was less than USD100 a head. It created the chaebol growth model, industrialised and introduced democracy in 1987. But there are numerous parallels between its economic history and Japan’s.

Both countries were rebuilt rapidly from the devastation of war through export-oriented growth and are now among the world’s most advanced economies. However, concerns over South Korea’s economic prospects have grown since Japan’s asset-bubble burst in the late 1980s. Five major structural similarities between the two economies suggest to some that they may share the same fate.

A shrinking labour force reduces an economy’s productive capacity unless there is capital or productivity growth. Japan’s working population has contracted since 1996 and Korea’s is projected to decline from 2017. Over the medium term, their demographic trends will converge.

Korea’s current investment-to-GDP ratio is 29 per cent, only slightly below the 32 per cent Japan reported in 1990. But high investment has been accompanied by lower productivity and Korea’s productivity growth has trended down over the past two decades, raising concern over the sustainability of its growth model.

Between 1985 and 1999 Japan’s potential growth rate fell from 4.6 per cent to 1.1 per cent. Since 2000, Korea’s rate has also declined.

Industrialisation in both countries was driven by large conglomerates – chaebol – that still have great economic influence. And like Japan, rather than the US, key industries dominate stock market indices.

Korea, like Japan, has rigid labour laws and strong trade unions. The cost of dismissing full-time staff has created a two-tier jobs market with high numbers of part-time workers, temporary staff or contract employees with lower skills who, on average, earn half the pay of full-time workers. Korea’s female participation rate of around 50 per cent is below the Organisation for Economic Co-operation and Development average of 66 per cent.

But despite these structural similarities, for Korea to become a replica of Japan it would have to see domestic demand plunge on the back of a popping asset bubble, prolonged deflation, and falling exports as manufacturers lose competitiveness.

We think Korea is unlikely to become “the next Japan”. There are no signs of asset bubbles forming: indeed, officials have been trying to revitalise the stagnant housing market. And deflation risks are low with inflation below target last year, reflecting weak global demand. Meanwhile, increased competitiveness means manufacturers have gained a higher share of the global export market.

But there is no room for complacency. Korea needs to return the economy’s potential growth from 3.4 per cent to around 4 per cent. It must learn from Japan’s mistakes and implement reforms, including raising financial transparency, normalising the policy rate when growth conditions warrant, and attracting more foreign workers.

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